What is the difference between a discounted gift trust and a loan trust for IHT?

Full answer

Discounted gift trusts (DGTs) and loan trusts are both popular IHT planning structures involving placing money into a discretionary trust while retaining some form of benefit. They are frequently compared because both are offered by insurance companies as investment bonds held in trust. However, they work quite differently and suit different planning needs. DISCOUNTED GIFT TRUST (DGT): You invest a lump sum into a discretionary trust but carve out ('reserve') the right to receive regular fixed income payments from the trust for the rest of your life. An actuary calculates the present value of these retained income payments -- the 'discount' -- based on your age, health, the income amount, and investment assumptions. The chargeable lifetime transfer (CLT) into the trust is the investment amount MINUS the discount. For example, invest GBP 200,000, retain income worth GBP 50,000 (actuarially valued) -- the CLT is GBP 150,000. Only GBP 150,000 counts against the nil-rate band (GBP 325,000 for 2026/27). The remainder (GBP 150,000) falls outside the estate after 7 years of survival (the 7-year clock starts at outset). The retained income right (GBP 50,000) remains in your estate but diminishes each year as you receive payments. You CANNOT get capital back -- you are locked into the fixed income. If you need the capital, you cannot access it. If the trust fund runs dry (investment underperformance), your income stops. LOAN TRUST: You lend money interest-free to a discretionary trust, documented by a loan agreement. The full loan (e.g. GBP 200,000) remains in your estate as an asset (a loan receivable). But ALL growth on the investment inside the trust is immediately outside your estate -- from day one. There is no immediate reduction in the chargeable transfer (no discount); the CLT into the trust is typically just the small initial gift (e.g. GBP 100). The IHT benefit builds as the loan is gradually written off (e.g. GBP 3,000/year using annual exemptions) and as investment growth accumulates outside the estate. You CAN get capital back by requesting repayment of the loan. The trustees can repay some or all of the loan to you if you need the money. This makes loan trusts more flexible than DGTs for people who may need access to capital. COMPARISON TABLE: - Immediate estate reduction: DGT = yes (the discount); Loan trust = no (full loan stays in estate). - Growth sheltered immediately: DGT = yes; Loan trust = yes. - Access to capital: DGT = no (locked into fixed income); Loan trust = yes (loan can be repaid). - Income flexibility: DGT = fixed income only; Loan trust = can repay capital which you then spend or gift. - Health requirements: DGT = actuarial assessment of health required (affects discount size); Loan trust = none. - Chargeable lifetime transfer amount: DGT = reduced investment minus discount; Loan trust = tiny (just the initial gift). - 7-year clock: DGT = starts immediately on the discounted amount; Loan trust = starts as loans are written off as PETs/CLTs. - Relevant property charges: both are subject to 10-year periodic charges (max 6%) and exit charges as discretionary trusts. WHEN TO USE WHICH: - DGT: suitable for those who need regular income from the trust fund, are in reasonably good health (better discount), do not need capital access, and want an immediate IHT reduction on entry. - Loan trust: suitable for those who need flexibility to access capital, do not need the immediate IHT reduction, or whose health would result in a very small discount making the DGT unattractive. Both structures require regulated financial advice and should be set up by a specialist with suitable trust documentation.

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